DP8378 Relational contracts when the agent's productivity inside the relationship is correlated with outside opportunities

Author(s): Alexander F Wagner
Publication Date: May 2011
Date Revised: September 2013
Keyword(s): Relational contracts, Repeated games
JEL(s): D23, D82, M51
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8378

An agent can choose to forego benefits from side opportunities and to instead provide benefits to the principal. In return, the principal offers rewards. If this exchange is not contractible, typically repeated interaction will be required to sustain it. This model allows the agent's productivity in contractible and possibly also non-contractible actions inside the relationship to be correlated with productivity in side activities. This arguably realistic assumption yields several novel implications for the feasibility of relational contracts and for agent selection by principals. The analysis reveals, for example, that optimal agent productivity is often non-monotonic in the importance, to the principal, of ensuring agent reliability.